On April 7, 2026, the U.S. and Iran agreed to a cease-fire for two weeks, subject to a number of conditions, including the complete opening of the Strait of Hormuz. As a result of the announcement, oil prices have declined by 15%, and European natural gas prices by 14%.
We believe the agreement is fragile and are skeptical that it will last the full two weeks. In the 24 hours since the agreement was announced, Saudi Arabia’s East-West Pipeline was hit by a drone attack, Kuwait’s air defense has intercepted 28 drones targeting energy infrastructure, and Israel has continued its attacks on Lebanon, which resulted in Iran halting oil tanker traffic through the Strait.
Regardless of whether we are correct about the duration of the cease-fire, three significant changes have taken place for energy fundamentals that are likely to result in higher prices than experienced over the past three years. First, we estimate that petroleum reserves have declined by about 150 million barrels (3% of total) since the beginning of the conflict. Each day that passes without normal flows through the Strait results in an additional 5-10 million barrels removed from inventory that will have to be rebuilt in the future, probably more than recent high-level marks due to real worries that the Strait can be closed.
Secondly, there is damaged infrastructure throughout the Gulf Coast countries, including Qatar, Kuwait, Saudi Arabia, the United Arab Emirates and Iran, that will require quarters or years to reestablish normalcy. Moreover, according to Kuwait Oil Company, even producing wells that were not attacked but were taken offline due to a lack of takeaway capacity will take more than several quarters to reestablish pre-conflict levels.
Thirdly, the spare capacity security blanket that had existed for the past 5 years is no longer. One item keeping oil prices low in recent years was ample spare capacity of about 4-5 million barrels per day from OPEC, specifically Saudi Arabia. Until normal supplies are reestablished and petroleum reserves are rebuilt, we will have almost no spare capacity. We believe this will take multiple quarters.
In this highly volatile environment, we are taking advantage of items in which we have a high degree of confidence. We are confident that natural gas prices will be higher in regions that depend on natural gas imports, such as Europe and Asia. Qatar Energy reported that an attack on its Ras Laffan facility (joint venture with Exxon Mobil) has taken 17% of its liquefied natural gas capacity offline for the next 3-5 years. As a result, the liquefied natural gas market has gone from modestly oversupplied to significantly undersupplied. This secular change is positive for companies that can sell natural gas into those importing regions. For example, independents and integrated companies that produce natural gas from the Norwegian Continental Shelf and sell into the EU, where realized natural gas prices are at a 2x-4x premium to its U.S. counterparts.
Source: Bloomberg, AAM; Henry Hub is U.S. benchmark; TTF is the Netherlands Title Transfer Facility
While fundamentals for energy companies will benefit from the supply shock of this conflict, valuations are unattractive. Over the past five years, the premium of the Energy sector’s option-adjusted spread (OAS) relative to Industrials has averaged 18%. Today, that premium is only 8%, or 2 standard deviations more expensive than average.
Source: Bloomberg, AAM; gray shading represents +/- 2 standard deviations
Disclaimer: Asset Allocation & Management Company, LLC (AAM) is an investment adviser registered with the Securities and Exchange Commission, specializing in fixed-income asset management services for insurance companies. Registration does not imply a certain level of skill or training. This information was developed using publicly available information, internally developed data and outside sources believed to be reliable. While all reasonable care has been taken to ensure that the facts stated and the opinions given are accurate, complete and reasonable, liability is expressly disclaimed by AAM and any affiliates (collectively known as “AAM”), and their representative officers and employees. This report has been prepared for informational purposes only and does not purport to represent a complete analysis of any security, company or industry discussed. Any opinions and/or recommendations expressed are subject to change without notice and should be considered only as part of a diversified portfolio. Any opinions and statements contained herein of financial market trends based on market conditions constitute our judgment. This material may contain projections or other forward-looking statements regarding future events, targets, or expectations, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved and may be significantly different than that discussed here. The information presented, including any statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Although the assumptions underlying the forward-looking statements that may be contained herein are believed to be reasonable, they can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. AAM assumes no duty to provide updates to any analysis contained herein. Past performance is not an indication of future returns. This information is distributed to recipients including AAM, any of which may have acted on the basis of the information or may have an ownership interest in securities to which the information relates. It may also be distributed to clients of AAM, as well as to other recipients with whom no such client relationship exists. Providing this information does not, in and of itself, constitute a recommendation by AAM, nor does it imply that the purchase or sale of any security is suitable for the recipient. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, inflation, liquidity, valuation, volatility, prepayment, and extension. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.
Middle East Ceasefire: What Has Changed for Energy Fundamentals and What Hasn’t
April 8, 2026
On April 7, 2026, the U.S. and Iran agreed to a cease-fire for two weeks, subject to a number of conditions, including the complete opening of the Strait of Hormuz. As a result of the announcement, oil prices have declined by 15%, and European natural gas prices by 14%.
We believe the agreement is fragile and are skeptical that it will last the full two weeks. In the 24 hours since the agreement was announced, Saudi Arabia’s East-West Pipeline was hit by a drone attack, Kuwait’s air defense has intercepted 28 drones targeting energy infrastructure, and Israel has continued its attacks on Lebanon, which resulted in Iran halting oil tanker traffic through the Strait.
Regardless of whether we are correct about the duration of the cease-fire, three significant changes have taken place for energy fundamentals that are likely to result in higher prices than experienced over the past three years. First, we estimate that petroleum reserves have declined by about 150 million barrels (3% of total) since the beginning of the conflict. Each day that passes without normal flows through the Strait results in an additional 5-10 million barrels removed from inventory that will have to be rebuilt in the future, probably more than recent high-level marks due to real worries that the Strait can be closed.
Secondly, there is damaged infrastructure throughout the Gulf Coast countries, including Qatar, Kuwait, Saudi Arabia, the United Arab Emirates and Iran, that will require quarters or years to reestablish normalcy. Moreover, according to Kuwait Oil Company, even producing wells that were not attacked but were taken offline due to a lack of takeaway capacity will take more than several quarters to reestablish pre-conflict levels.
Thirdly, the spare capacity security blanket that had existed for the past 5 years is no longer. One item keeping oil prices low in recent years was ample spare capacity of about 4-5 million barrels per day from OPEC, specifically Saudi Arabia. Until normal supplies are reestablished and petroleum reserves are rebuilt, we will have almost no spare capacity. We believe this will take multiple quarters.
In this highly volatile environment, we are taking advantage of items in which we have a high degree of confidence. We are confident that natural gas prices will be higher in regions that depend on natural gas imports, such as Europe and Asia. Qatar Energy reported that an attack on its Ras Laffan facility (joint venture with Exxon Mobil) has taken 17% of its liquefied natural gas capacity offline for the next 3-5 years. As a result, the liquefied natural gas market has gone from modestly oversupplied to significantly undersupplied. This secular change is positive for companies that can sell natural gas into those importing regions. For example, independents and integrated companies that produce natural gas from the Norwegian Continental Shelf and sell into the EU, where realized natural gas prices are at a 2x-4x premium to its U.S. counterparts.
While fundamentals for energy companies will benefit from the supply shock of this conflict, valuations are unattractive. Over the past five years, the premium of the Energy sector’s option-adjusted spread (OAS) relative to Industrials has averaged 18%. Today, that premium is only 8%, or 2 standard deviations more expensive than average.
Disclaimer: Asset Allocation & Management Company, LLC (AAM) is an investment adviser registered with the Securities and Exchange Commission, specializing in fixed-income asset management services for insurance companies. Registration does not imply a certain level of skill or training. This information was developed using publicly available information, internally developed data and outside sources believed to be reliable. While all reasonable care has been taken to ensure that the facts stated and the opinions given are accurate, complete and reasonable, liability is expressly disclaimed by AAM and any affiliates (collectively known as “AAM”), and their representative officers and employees. This report has been prepared for informational purposes only and does not purport to represent a complete analysis of any security, company or industry discussed. Any opinions and/or recommendations expressed are subject to change without notice and should be considered only as part of a diversified portfolio. Any opinions and statements contained herein of financial market trends based on market conditions constitute our judgment. This material may contain projections or other forward-looking statements regarding future events, targets, or expectations, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved and may be significantly different than that discussed here. The information presented, including any statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Although the assumptions underlying the forward-looking statements that may be contained herein are believed to be reasonable, they can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. AAM assumes no duty to provide updates to any analysis contained herein. Past performance is not an indication of future returns. This information is distributed to recipients including AAM, any of which may have acted on the basis of the information or may have an ownership interest in securities to which the information relates. It may also be distributed to clients of AAM, as well as to other recipients with whom no such client relationship exists. Providing this information does not, in and of itself, constitute a recommendation by AAM, nor does it imply that the purchase or sale of any security is suitable for the recipient. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, inflation, liquidity, valuation, volatility, prepayment, and extension. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.
Patrick McGeever
Senior Fixed Income Credit Analyst & Principal
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